Congressional panel urges changes to financial rules

RonaldD. Orol

WASHINGTON (MarketWatch) - A key congressional panel called for sweeping regulatory reform for financial markets on Thursday, including broad changes to credit rating agencies, executive compensation policies and hedge fund rules, among many other suggestions.

The 109-page report written by a congressional oversight panel, authorized by Congress to examine the financial system, makes a series of legislative and regulatory recommendations for lawmakers, the Securities and Exchange Commission and federal bank agencies to consider. (Read report)

The five-member bipartisan group is made up of Harvard Law School Professor Elizabeth Warren and four other members. The panel's two Republicans, ex-Senator John Sununu and Rep. Jeb Hensarling, R-Texas, rejected the report.

It broadly calls for special rules for large "systemically significant" institutions to reduce the risk that such a mega-corporation's collapse might have on the markets. The report doesn't name any specific corporations, but calls from more stringent capital and liquidity requirements for firms in this category. The SEC has been criticized for failing to require investment banks, including Bear Stearns and Lehman Brothers, to maintain sufficient capital on-hand.

In a section of the report on investor oversight, the report recommends that Congress write rules requiring hedge fund managers register and open up their books periodically for SEC examiners.

As part of the investor section, the report also suggests that regulators should require derivatives investors to hold a significant amount of capital while limiting the leverage they can employ. The report also recommends setting up exchanges for credit default swaps, an insurance product considered a key contributor to the financial crisis.

It also recommends the creation of tax incentives that would encourage CEO pay plans focused on longer-term multi-year goals, rather than the existing shorter-term incentive structure.

Changes for credit rating agencies

The report suggests changes to regulations of credit rating agencies, which have also been charged with contributing to the financial crisis by issuing AAA ratings to problematic mortgage-backed securities. The report also expresses concern about problems with the existing system where corporations pay rating agencies for ratings. "

To resolve this situation, the panel has made a number of suggestions. With one possibility, a corporation seeking a rating would pay a fee to an entity that would choose a rating agency at random. The report also suggests expanding the number of rating agencies that could qualify as a National Recognized Statistical Rating Organization, a credit rating agency recognized by the SEC. So far, the SEC has recognized ten credit rating agencies under this category.

The oversight panel suggests that Congress could create a Credit Rating Review Board, funded by corporate fees, which would sign off on any private rating before it was approved. In addition to auditing ratings, the board would make sure that rating agencies are disclosing their methodologies. It could also periodically inspect and discipline rating agencies.

Other recommendations

A number of long term recommendations were also made, including one that suggested the creation of a Financial Risk Council of outside experts that would report to Congress on financial challenges looming on the horizon. Council members would contemplate various scenarios for a "worst case financial crisis" and consider solutions.

Members did not make recommendations on a number of other issues, but recommended that policy makers conduct further studies on hedge fund short selling, the "logic and limits" of mortgage securitization and accounting models.

SEC officials are already reviewing whether changes are necessary to its accounting rules and short selling regulations. SEC chairwoman Mary Schapiro suggested considering the return of the "uptick" rule, a regulation removed last year that allowed short sales only if a preceding trade boosted a company's stock price, when she was questioned by lawmakers at her confirmation hearing on Jan. 15.

Hensarling and Sununu made a series of recommendations of their own. They argued that quazi government-private agencies Fannie Mae and Freddie Mac contributed to the financial crisis by purchasing and securitizing sub-prime loans "regardless of their quality." The duo also criticized the NRSRO system arguing that it "established an insurmountable barrier to entry into the rating business, eliminating market competition among the rating agencies."

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